The world’s biggest companies will find it harder in 2019 to set up some business structures that let them achieve the lowest tax rates, after a novel new multilateral treaty goes into effect.

“Treaty shopping has come to an end,” said Pascal Saint-Amans, director of the Organization for Economic Cooperation and Development’s Center for Tax Policy and Administration.

Heading into 2019, 85 jurisdictions have signed and 17 have ratified the multilateral instrument (MLI), which enters into effect Jan. 1. That means it will begin modifying the bilateral tax treaties of 15 jurisdictions which have already ratified the measure, including Australia, France, Japan and the U.K.

One of the most significant and immediate of consequences of the MLI is the provision that shuts down “treaty shopping,” in which multinational companies route profits through low– or zero–tax jurisdictions to avoid paying taxes in a third jurisdiction. That provision, the Principal Purpose Test (PPT), will shift more power and potentially more revenue into the hands of tax authorities, result in fewer opportunities for corporations to lower their global tax bills—and add a new layer of uncertainty for companies trying to tax plan.

The PPT, or something that achieves the same effect, will eventually be adopted into all of the more than 1,500 bilateral tax treaties covered by the MLI. Bilateral treaties are updated after both parties ratify the MLI, and the OECD is expecting a “snowball effect” of more ratifications in the coming year, Saint-Amans told Bloomberg Tax.

“It’s true that the real end will come when all the countries which have signed have ratified,” Saint-Amans said. But the PPT may already be affecting corporate behavior around treaty shopping, he added. “Companies know that it’s going to change.”

Why it Matters

The MLI is a linchpin of the OECD’s work to tighten global tax rules to prevent corporations from artificially shifting their profits to lower-tax jurisdictions.

The tax super-treaty marks a major milestone in the Organization for Economic Cooperation and Development’s project to crack down on base erosion and profit shifting (BEPS). The instrument is designed to bring bilateral tax treaties up to date with new, stricter global standards much more quickly and efficiently than before.

It also means an overhaul of the process companies rely on to avoid being taxed twice. Bilateral tax treaties are a critical factor in multinationals’ decisions about how to structure their business and where to invest.

When the OECD began its BEPS efforts in 2013, treaty shopping was one of its most pressing concerns, “and we have a concrete solution a few weeks from now,” said Maikel Evers, an OECD adviser and coordinator of the MLI.

When a jurisdiction signs the MLI, it can choose which provisions it will include into its treaties, including measures aimed at the artificial avoidance of taxable presence or hybrid mismatches. Companies use hybrid mismatch structures to lock in a more favorable tax outcome.

Principal Purpose Test

The PPT lets tax authorities assess whether they think a business structure is located in their jurisdiction for the benefits of the tax treaty above all—and then deny treaty benefits to the company if so. The provision is designed to put more power in the hands of tax authorities by letting them decide subjectively what a structure’s “principal” purpose is.

That potential clout has companies concerned.

“The big problem with the PPT is that no one really knows how to interpret it exactly,” said Margriet Lukkien, a partner at Loyens and Loeff in Amsterdam. “‘Principal’ is really a vague word, and there’s not a lot of guidance from the OECD or from relevant countries.”

That ambiguity “is going to introduce a fair amount of uncertainty as we find out how tax administrations will apply that rule,” said Jesse Eggert, a principal at KPMG LLP’s Washington National Tax Practice. Eggert is a former senior adviser with the OECD’s Centre for Tax Policy and Administration.

That uncertainty could turn into disputes between governments and companies in a few years if tax authorities challenge business structures, he said.

But some of that effect was by design.

“We’ve put in place a mechanism which has some level of uncertainty,” Saint-Amans said. “It will oblige companies to reflect, does or doesn’t it hold? They may need to bring real substance.”

The PPT will become most effective once the MLI is ratified by countries known as treaty shopping hubs, like the Netherlands, Mauritius, and the United Arab Emirates, Saint-Amans said. All three have already signaled their interest by signing the MLI and designating many of their treaties to be subject to its changes, Saint-Amans said.

None has yet deposited its instrument of ratification with the OECD, but the Netherlands is likely to do so in 2019, Lukkien said.

How to Navigate the Changes

One way for companies to prepare for the PPT is to carefully document their positions and reasons for creating their structures, both to minimize controversy and to be prepared for the possibility of increased controversy, Eggert said.

“Because it’s relatively uncertain, there’s a risk of increased controversy,” he said. “Careful and consistent documentation is going to be an important part of making sure they’re prepared for that controversy.”

The PPT may mean some companies will restructure to ensure they have people functions in jurisdictions where they have legal structures, or to match their legal structures to where their people are, Lukkien said. The same goes for any other BEPS measures that put more emphasis on making sure companies can prove they have a real business reason for operating in a jurisdiction.

What’s Next?

It is likely that by September 2019, the MLI will have been ratified by a majority of the first wave of countries that signed it, Evers said. In June 2017, 76 jurisdictions signed or formally expressed their intention to sign the MLI at its unveiling.

The PPT will likely see even wider pickup at the start of 2020. Any jurisdiction that ratifies the MLI and notifies the OECD by Sept. 1, 2019 will see it modify provisions in their bilateral treaties that are related to withholding taxes, which will likely be affected by the PPT, on Jan. 1, 2020.

Over the next year, the OECD will be working on “housekeeping” tasks to support countries’ implementation of the MLI, like issuing guidance. The organization will also work on measuring the PPT’s effectiveness, Saint-Amans said, with a view to presenting to a Group of 20 finance ministers’ meeting in June 2019 “a sense of the impact” the measure is having, such as greater tax revenue collection in source countries.

Meanwhile, more jurisdictions will likely sign the MLI, the signal they are prepared to start working toward ratifying it through domestic procedure.

“We’ll reach 100 at some point,” Saint-Amans said. “But more importantly, is the fact that you have all the treaty shopping hubs that have been here since the beginning.”